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International Securities Exchange
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Steve Meizinger
Steve of
Meizinger
Director
Education
ISE
ISEoptions.com
[email protected]
2
Spread Opportunities Using ISE Sector
Indexes
(RUF)
3
For the sake of simplicity, the examples that follow do not take into consideration
commissions and other transaction fees, tax considerations, or margin
requirements, which are factors that may significantly affect the economic
consequences of a given strategy. An investor should review transaction costs,
margin requirements and tax considerations with a broker and tax advisor before
entering into any options strategy.
Options involve risk and are not suitable for everyone. Prior to buying or selling
an option, a person must receive a copy of CHARACTERISTICS AND RISKS OF
STANDARDIZED OPTIONS. Copies have been provided for you today and may
be obtained from your broker, one of the exchanges or The Options Clearing
Corporation. A prospectus, which discusses the role of The Options Clearing
Corporation, is also available, without charge, upon request at 1-888-OPTIONS
or www.888options.com.
Any strategies discussed, including examples using actual securities
price data, are strictly for illustrative and educational purposes and are not to be
construed as an endorsement, recommendation or solicitation to buy or sell
securities.
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www.iseoptions.com
• Free volatility data on all ISE listed options
• Updates on ISE broad market index products
• Updates on ISE sector options
• [email protected]
5
Rights and Obligations
• Options are contracts
• Option buyers get rights
Call buyers get the right to buy
Put buyers get the right to sell
• Option sellers get obligations
A short call is an obligation to sell
A short put is an obligation to buy
6
Options have value for two reasons
• The cost of money - The risk-free rate that money
can be invested less any dividends that are paid
• Volatility - The movement of stocks is measured by
the standard deviation
7
Option Greeks: A refresher
•
•
•
•
•
Delta
Theta
Gamma
Vega
Rho
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Delta
• How much an option price changes relative to the
underlying price changing $1.0
Deep in Money - Have intrinsic value and have
higher deltas
At the Money - Have no intrinsic value and have
deltas that are approximately 50%
Out of the Money - Have no intrinsic value and
have lower deltas
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Different underlying prices and maturities affect delta
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Theta
• The amount an option depreciates as measured on a daily
basis
• Also called time decay
• Options are generally worth more given more time until
expiration
• Time decay is not linear, much greater impact with few days
left until expiration relative to many days left until
expiration
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Call option value
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Theta graphically
13
Gamma
• Gamma is an estimate of how much the delta of an
option changes when the price of the stock moves
$1.00
•
Gamma is “potential” delta
•
Gamma is inversely related to theta, the more
gamma an option has the more time decay or theta
an option has
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Vega
• An estimate of how much the theoretical value of an option
changes when volatility changes 1.00%
• Higher volatility translates to higher option prices
• If an underlying has a 16 volatility its expected daily range
is .16/square root of trading days (approximately 16) = 1%
• 40 volatility/16 =.025* underlying (RUF $26.48) = $0.66 is the
one standard deviation expected range for RUF assuming
40 volatility and an index value of $26.48
• The higher the volatility the greater the expected range
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Rho
• Rho is an estimate of how much the theoretical value
of an option changes when interest rates move
1.00%
• Least used of all the “Option Greeks”
16
Options are dynamic
• Using options, investors can choose price forecasts,
time forecasts or volatility forecasts or a combination
of all three
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Spreads
• The term “spread” is loosely used term that can
describe any multiple-leg part strategy
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Why trade spreads?
• Spread strategies offer investors and traders unique
sets of trade-offs
• Spread strategies offer lower risk with reduced
upside/downside depending on the strategy selected
• For a particular market forecast, a spread strategy
may offer a better risk/reward ratio or higher profit
potential
19
Spreads assist in hedging
• Spreads can help mitigate risk
Volatility risk (Vega)
Time decay risk (Theta)
Underlying price risk (Delta)
• Spreads create an efficient way of creating long or
short delta exposure
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Bull call spread
• Bull call spreads involves the purchase of one call
and the sale of another call with a higher strike price.
Both options have the same underlying and the same
expiration date
• Bull call spreads are known as debit spreads, they
are one type of vertical spread
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Index options
• Index options enable investors to gain exposure to the
market as a whole or to specific segments of the market
with one trading decision and frequently with one
transaction. To obtain the same level of diversification
using individual stock issues or individual equity option
classes, numerous decisions and transactions would be
required. Employing index options can defray both the
costs and complexities of doing so.
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ISEoptions.com
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ISE Homebuilders (RUF)
• The ISE Homebuilders Index includes residential
construction companies and prefabricated house
manufacturers
•
The largest weightings in the index are: Lennar
Corp, Pulte Homes, Centex Corp, D.R. Horton, KB
Home, Toll Brothers and NVR Inc
Please visit www.iseoptions.com for further
information regarding ISE indexes
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ISE Homebuilding index (RUF)
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RUF volatility has been increasing
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Spread Strike selection
• Deciding which strikes to spread depends on your
forecast and the market’s forecast
ITM, ATM, OTM
• Depends on your view of:
time passage (theta)
implied volatility (vega)
• Another consideration: Is the option that you sell
worth selling? If the bid if is too low, it may not worth
selling
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Bullish call spread using RUF
• With RUF trading at 26.48
(Index forecast: (Up 4% by expiration, 38 days)
Buy 1 RUF Sept 25c at $2.35
Sell 1 RUF Sept 27.5c at $0.95
Net debit
$1.40
• The 25-27.5 RUF Call spread is purchased for $1.40,
or $140, plus commissions
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RUF Bull Call spread at expiration: cost (1.40)
RUF index
RUF Sep 25c
RUF Sep
27.5c
RUF Sep
25/27.5 call
spread
22.5
($2.35)
$0.95
($1.40)
25
($2.35)
$0.95
($1.40)
26.48
($0.87)
$0.95
$0.08
27.5
$0.15
$0.95
$1.15
30
$2.65
($1.55)
$1.15
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RUF Bull Call diagram
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RUF Index
• Indexes are cash settled, there is no need to worry
about closing out the spread for fear of residual
positions after expiration
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Another look: choosing between strategies
• RUF is 26.48
• Your forecast: You believe the index will be rise
approximately 4% to 27.5 at the option’s expiration
• Possible strategies
Buy RUF Sep 25c @$2.35
Sell RUF Sep 27.5c @$0.95
Buy the 25/27.5c spread @$1.40
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Estimating Results
Today
At Expiration
Profit/(loss)
RUF Index
$26.48
$27.50
Not applicable
Sept 25 call
$2.35
$2.50
$0.15
Sept 27.5 call
$0.95
0
($0.95)
Sept 25/27.5
call spread
$1.40
$2.5
$1.10
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Another view: Bearish
• Bearish debit put spread involves the purchase of
one put and the sale of another put with a lower strike
price. Both options have the same underlying and
the same expiration date
• Bear put spreads are also a type of a vertical spread
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RUF Put Spread
• RUF is quoted at $26.48
Buy RUF Sept 27.5p @$1.90
Sell RUF Sept 25p
@$.75
Net debit
$1.15
• The 27.5/25 RUF put spread is purchased for a $1.15
debit or $115 not including commissions
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RUF Bear Put Spread at expiration: cost (1.15)
RUF Index
Sept 27.5p
Sept 25p
RUF Sept
27.5/25p
22.5
$3.10
($1.75)
$1.35
25
$.60
$0. 75
$1.35
26.48
($0.88)
$0.75
($0.13)
27.5
($1.90)
$0.75
($1.15)
30
($1.90)
$0.75
($1.15)
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RUF Bear Put Spread
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Need more time for your RUF forecast?
• RUF is 26.48
• Your forecast: You believe the index will rise
approximately 13%, although it will take 4 months for
that to occur
• Buy RUF Dec 25c @ $3.50
Sell RUF Dec 30c @ $1.30
Net debit
$2.20
• The Dec 25-30c RUF Call spread is purchased for
$2.20, or $220, plus commissions
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More time for our forecast to true
RUF Dec 25-30 call spread debit $2.2
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Options give you alternatives
Today
At Expiration
Profit/(loss)
RUF Index
$26.48
$30.00
Not applicable
Dec 25 call
$3.50
$5.00
$1.50
Dec 30 call
$1.30
0
($1.30)
25/30 call
spread
$2.20
$2.80
$2.80
40
More time needed for a bearish forecast
• RUF is 26.48
• Your forecast: You believe the index will decline
approximately 5%, although it will take 4 months for
that to occur
• Buy RUF Dec 30p @ $4.50
Sell RUF Dec 25p @ $1.60
Net debit
$2.90
• The Dec 25-30 RUF put spread is purchased for
$2.90, or $290, plus commissions
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More time for a bearish forecast
RUF Dec 30-25 put spread debit $2.9
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RUF Bear Put Spread at expiration: cost (2.9)
RUF Index
Sept 30p
Sept 25p
RUF Sept
27.5/25p
22.5
3.00
(.90)
2.10
25
.50
1.60
2.10
26.48
(.98)
1.60
(.08)
27.5
(2.00)
1.60
(.40)
30
(4.5)
1.60
(2.90)
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Risk/Return
• Risk and return are inherently linked
• Each investor must weigh their own investment goals
and their own risk tolerances
• Selecting time frame and strike prices is based on
your forecast and your risk tolerances and your
financial goals
44
Summary
• Spread strategies offer lower risk with reduced
upside/downside depending on the strategy selected
• For a particular market forecast, a spread strategy
may offer a better risk/reward ratio or higher profit
potential
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Caution
• Just remember the market does not care what price
you paid for your spread
• All option strategies work, but they do not work all the
time
• Trade within yourself based on your own investment
goals and your own risk tolerances
46
www.iseoptions.com
• Free volatility data on all ISE-listed options
• Updates on ISE broad market index products
• Updates on ISE sector index options
• New webinar options topics each month
47
International Securities Exchange
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